- The Washington Times - Tuesday, September 21, 2004

The Federal Reserve yesterday dismissed lingering concerns about the drag on the economy from high oil prices and approved its third and final quarter-point rate increase before the elections.

Fed officials have blamed this year’s spike in oil prices, which jumped to nearly $47 a barrel in New York trading yesterday, for an uptick in inflation and a slowdown in job gains and economic growth.

But yesterday, the central bank said both problems appear to be easing, enabling it to continue its string of “measured” rate increases about every month and a half.

“Growth appears to have regained some traction, and labor market conditions have improved modestly,” the Fed’s rate-setting committee said, “after moderating earlier this year partly in response to the substantial rise in energy prices.”

Consumers, hit by the double whammy of rising interest rates and gasoline prices, have slowed their pace of spending this summer, leaving the economy growing at a lackluster rate of about 3 percent.

But the rate increases engineered by the Fed so far have been gradual and gentle on consumers and have had only a moderate impact on the most rate-sensitive purchases: homes and autos.

Rising mortgage rates, which, on average, are a half-point higher than a year ago, barely have made a dent in the booming market for new homes. A report from the Commerce Department yesterday said starts on new-home construction projects remained near record levels of more than 2 million last month.

“The gradual approach barely upsets the economic expansion,” even as it quells the possibility that surging energy prices will stoke a renewed bout of inflation, said Richard Yamarone, economist with Argus Research Corp.

Oil prices of more than $35 are “here to stay,” he said, and businesses will be hard-pressed in the months ahead to pass those high costs along to consumers. That would trigger inflationary increases in prices for a wide range of products from plastic and fertilizer to minerals and transportation, he said.

“The Fed is in a tough position today because an important underlying cause of inflationary pressures is a rise in oil prices — something that the Fed cannot affect with interest rate increases,” said Ann Owen a former Federal Reserve economist and Hamilton College economics professor.

The jump in oil prices to $46.76, where they ended in New York trading yesterday, has been attributed largely to developments outside the Fed’s control, including political instability in oil-producing regions such as Iraq, Saudi Arabia and Russia.

“By raising rates, the Fed can hope to reduce inflationary pressures throughout the economy, but it cannot have a significant impact on oil prices,” Ms. Owen said.

“The increased interest rates will undoubtedly cost jobs” in housing, autos and other areas as rates steadily rise in the months ahead. But the Fed thinks that the greater risk is that surging energy prices will fuel a renewed round of inflation, she said.

The Fed yesterday raised the rate it targets on loans to banks by a quarter-point to 1.75 percent. Its action is expected to trigger a similar increase in the prime lending rate and consumer loan rates, including on home equity loans and credit cards.

Financial markets, befuddled by the mixed economic picture, reacted positively to the Fed’s statement yesterday expressing faith in the durability of the U.S. economic expansion. The Dow Jones Industrial Average rose by 40 points to 10,245.

“The economy is neither roaring nor stalling; it’s clearly out of the soft patch and moving along at a decent pace,” said Bill Cheney, chief economist with MFC Global Investment Management.

“Aside from oil prices, which remain a wild card, the inflation outlook remains generally benign. This gives the Fed the luxury of moving slowly, giving time for the labor market to regain some momentum.”

Peter Morici, business professor at the University of Maryland, said American consumers have felt little impact from the Fed’s rate increases so far, because they have been blunted somewhat by the central banks of China and other East Asian countries.

The foreign central banks have been keeping the rates on mortgages and other long-term bonds low with massive purchases of U.S. bonds this year.

The goal of these securities purchases is to prop up the dollar and enable U.S. consumers to keep buying Chinese and other Asian goods at cheap rates, Mr. Morici said, thus counteracting the Fed’s goal of moderating consumer spending and economic growth.

“Mr. Greenspan is pushing on a string, because China has seized global monetary policy from the Americans,” he said.

Other economists say the Fed undoubtedly was aware the foreign central bank actions would dull the impact of its own rate increases — and perhaps even was counting on that.

Fed Chairman Alan Greenspan has expressed little concern about foreign central bank activities in testimony, although he has said he thinks China eventually will have to stop propping up the dollar because it is stimulating growth too much not only in the United States but in its own economy. China has posted near double-digits growth rates in recent years.

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